QE2: Not A Luxurious Ocean Liner

Last week, the markets were all abuzz with talk of Quantitative Easing, or QE.  QE is a way to increase the money supply when the cost of money is at or close to zero.  In late 2008, the Federal Reserve flooded the marketplace with a couple of trillion dollars on a monthly basis through March 2010.

This is a process I’d love to be able to do with my own accounts. The Feds credit its own account with money created “ex nihilo,” meaning “out of nothing.” Then it purchases financial assets like government and corporate bonds from banks and other financial institutions.  The purpose is to increase the money supply, thereby stimulating the economy.  The Feds decided to pump 600 billion dollars into the economy beginning this week and ending some months from now. 

This action begs the question: If trillions of dollars were “floated” in 2008 to early 2010 and banks sat on it and unemployment was up and growth was slow, then whose big idea was it that generating more money would cause a different reaction of any kind?  Japan is following our lead and using a similar policy, but Great Britain has said, “No thanks; we are fine with cutting spending and benefits.”

Japan used this process unsuccessfully in their long recession over 10 years ago.  But they love to imitate the US, and they are going along with us, this time.  In March, I wrote about some of the pitfalls of this economy on a global scale regarding long-term treasury bonds. Those concerns remain.  The Feds seem to have learned little from our problems or from the problems seen in Europe and around the world.

Many of the big financial institutions like Goldman Sachs think we aren’t doing enough. They are predicting stagnant inflation, unemployment, and real estate trends until 2015.  According to this model, we will experience a 10-year recession.  But will we, really? 

These cycles are all exacerbated by a convoluted financial policy that is focused on numbers and not on the exceptionalism of the American people. It seems that every 40 years we have to relearn our economic history.  We have had long recessions or depressions in the 1930s and 1970s, and now it seems as if the 2010s will usher in the next 10-year cycle of stagnant growth.  In between, we seem to “bubble” about every 10 years with a small recession.  But monetary policy is the key, and this monetary policy, the QE2, could create more of the “bubbles” we want to avoid.  If we back up and let the markets rule with limited oversight, we might get out of the slowdown and get back to work more quickly.  When we look to the Germans, the Brits, and even the French for examples of good monetary and budgetary policy, you know we are in trouble!

There are two key points from the QE2 announcement. First, no one expects that this announcement of a 600-billion-dollar figure is going to stay at that number. Most in the field believe there will be another announcement in 2011 of much more to be put in the market to “best foster maximum employment and price stability.” The powers that be in the financial world are predicting close to 10% unemployment for the near and far terms. We can’t accept that, and it’s time to educate ourselves on these policies.

Second, this movement shows the markets the Feds expect interest rates to be at or near zero for up to several years. Projection models show no tightening up until 2015. This may mean a long and slow improvement, and is not as important as the jobs numbers.  Getting people back to work should be priority number one, and that is going to take a loosening up of credit on the ground level to the consumer and to the small business owners.

Make no mistake:  QE2 is a “back-door” bank bailout and will put funds into bank coffers.  Most banks are still insolvent with toxic assets not marked to market and on banks’ books at inflated values.  QE2 will help the banks’ balance sheets.  That’s the intent of it.  What banks will do with the funds—lend or invest—is unknown.  What is known is that it will more than likely create more bubbles and “kick the can down the road” again.  The Feds’ attempt is to elevate asset prices and, hopefully, because of the “wealth effect,” to increase demand and consumption, but there are no guarantees.

In a nutshell, QE2 or not, unemployment will remain high for the foreseeable future, housing prices will continue to fall, and foreclosures and inventory will be increasing. Growth will remain anemic. It’s not all bad news, but we have to be realistic. In addition, we need to demand that the new Congress be realistic also. They should focus only on the big issues and not waste time on unnecessary hearings or resolutions.  We can change the current outlook with the right fiscal policies in place.

This much is certain:  If we don’t get people back to work and restore free-market principles to the economy, we will have the long winter night that Europe has been experiencing for the last two generations. Their troubles are not over, and we need to learn from them and to change our direction to avoid stagnant growth for a decade.